One of my favorite scenes in the Pixar movie Finding Nemo comes at the end. The fish had managed to outwit the Dentist (who was holding them captive in a tank) by dirtying the water enough to force a water change. In order to do that, the Dentist had to bag the fish and leave them outside the tank, at which point they jumped out the window and into the harbor below. Unfortunately, they hadn’t considered how they were going to get out of the plastic bags. The movie ends with one of the fish asking, “Now what?”
The Federal Reserve spoke yesterday, and not surprisingly decided to buy more treasury bonds to keep expanding the balance sheet. It might have been a bit surprising that they have now also explicitly targeted an improvement in the unemployment rate (6.5%) and stated a tolerable inflation band (2.5%) for investors to use as guides for when the Fed might engage in policy withdrawal. The market went up for a few hours, and then drifted back to earth and closed unchanged on the day; Fed decisions can’t force politicians to trade in political theatre and come up with a deal before the 11th hour.
Everybody knows that the dice are loaded.
Everybody rolls with their fingers crossed.
Everybody knows that the war is over.
Everybody knows the good guys lost.
Everybody knows the fight was fixed.
The poor stay poor, the rich get rich.
That’s how it goes,
Leonard Cohen, “Everybody Knows”
Right now we sit in an unusual place in financial history: World fundamentals are taking a back seat to policy makers who are defending the current system with new monetary tools. As market analysts, we’ve watched the perpetual bull and bear debate grow as divisive as ever, and while both camps have impressive arguments, neither camp has enough history to make their case.
On October 7, 2011, I wrote a blog post describing a bullish divergence forming in the Financial Sector SPDR. I used the Relative Strength Indicator to measure momentum and the price of the XLF to show that although the XLF made a new price low, the indicator did not confirm the drop. I could have used other indicators and equity positions, and the result would have been the same.
Bearish investors look at the chart below and immediately notice that Fed intervention in the form of QE1 and QE2 (quantitative easing program 1 and 2, or perhaps more accurately, money printing programs 1 and 2) occurred after substantial market declines. QE1 is announced after the Lehman Brothers collapse in 2008 and QE2 is hinted at when Bernanke addressed the Jackson Hole conference in the summer of 2010 (after we learned of the Greek debt problems). Given that last week’s news regarding fourth quarter GDP was somewhat disappointing, bears would warn risk takers not to count on the Fed to announce a new QE3 program that would support the equity markets until after the next major stock market correction, or bear market. In addition, the magnitude of the impact of the Fed announcements on the market seems to be diminishing. The market move during QE2 was less than QE1, and the subsequent policy shifts have had less impact than QE2.